How Will Japan Finance Its Reconstruction?

Japan's Nikkei index has dropped almost 10% since the earthquake hit, but this is not what most analysts are really worried about. Instead, they're looking at Japan's debt, and wondering how the government is going to finance a reconstruction that will require mind-boggling sums, as the BBC points out: "The sum that Japan needs to borrow this year is the kind of number that boggles the brain: if you add together both the maturing debt that needs to be repaid and new borrowing to finance the deficit, Japan needs to borrow around a third of its $5.5 trillion GDP, excluding very short term debt, or more than half its GDP including short term debt."

That borrowing is going to come atop an already colossal debt burden--Japan's debt-to-GDP ratio is currently well over 200%. This can't go on forever . . . is this when it stops?

In the short term, no, for two reasons. As Nomura points out in the BBC link, the Bank of Japan is . . . er . . . [insert some metaphor for supergoosing the money-supply that does not involve floods.] In the short term the BOJ's actions may actually increase the price of Japanese bonds--and according to Nomura, the ratings agencies are probably going to cut Japan some "humanitarian" slack.

There's also the fact that most of Japan's borrowing is done not only in its own currency, but from its own people. This means you're not going to see the sort of capital flight that has brought down other heavily indebted countries. And in the immediate aftermath of a crisis, I expect that Japan is going to experience the sort of patriotic surge that temporarily unified America after 9/11. I doubt their willingness to lend will flag in the near term; it will, indeed, probably increase.

On the other hand, it's very much in question whether Japan can really finance all of this on its own resources. 1/3 of GDP is a lot of borrowing. It's not impossible--we borrowed 30% of GDP in 1943. But we started with a pretty low debt burden.

Moody's can offer Japan a "humanitarian" extension on getting its act together, but that doesn't mean that people outside the country are necessarily going to be willing lenders--at least, not at the same prices that Japan's savers have given. The Bank of Japan can ease the money supply--but it can't supply the real resources that Japan will need to rebuild from this disaster.

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